Cowen Has the Ultimate Social Media Stock Trade

Social media continues to grow, and part of the big increase is due to mobile apps for the top social media websites. However, one thing is starting to show up in the monthly social media metrics numbers. There is a dominant winner in the space, and others are doing everything they can to stay up to speed.

In a new research note from Cowen, analysts feel that the winners are going to continue their winning ways, while the laggards may very well do the same and lag the competition. With Facebook Inc. (NASDAQ: FB) growing faster but trading cheaper, the Cowen team believes that the company’s better quality growth is likely to persist. They have a rating of Outperform on the stock, and a monster $85 price target. Facebook closed Monday at $64.19.

Conversely, the firm has been very negative on Twitter Inc. (NASDAQ: TWTR) since the company went public and remains so. The analysts have maintained their rating of Underperform on the stock for months and have a $26 price target. Twitter closed Monday at $38.02.

The trade that Cowen suggests for clients is called a pairs trade. It is a well-known and often used trade tactic where an investor buys a stock long and sells short a stock that is similar in nature by an equivalent amount. The two stocks that Cowen has suggested to their clients, and continue to recommend going forward, is a pairs trade involving Facebook and Twitter.

Here is how the trade could be structured. The client would buy long in the account 1,000 shares of Facebook at $64, a total outlay of $64,000 before any trading commissions. The client then sells short in the account a commensurate amount of Twitter, which if priced at $37, would be approximately 1,730 shares at this time.

The logic is reasonably straightforward, Cowen likes the prospects for Facebook, but not Twitter. The investor wins both ways if Facebook goes up and Twitter goes down. The investor can still make money if Facebook and Twitter both rise, but obviously less. The losing side of the trade would be Facebook trading down and Twitter trading higher.

The bottom line is that, despite solid growth, Twitter doesn’t make very much money. On estimated 2014 revenues of $1.27 billion, Wall Street analysts have the firm making a whopping $0.04 in earnings per share. The end result is a gigantic price-to-earnings multiple. On 2015 earnings of an estimated $2.04 billion, it is expected to make $0.25 per share, or a gigantic 148 times next year’s earnings.

Facebook is expected to earn $1.43 per share this year on $11.84 billion in revenue, and $1.83 on $15.59 billion in revenue in 2015. That is equal to a 34-times price-to-earnings multiple. Rich perhaps, but nothing like the gigantic Twitter number.

Most importantly, Facebook has a huge demographic advantage, and it is much more user friendly, especially for older clients. Think about it, your grandmother may very well have a Facebook account that she is very active in. The chances that she is putting out multiple micro-posts on Twitter and following the newest reality TV star’s posts is unlikely.

At the end of the day, this is an aggressive trade only suitable for very risk-tolerant accounts. If Cowen is right, and it has been so far, this could continue to make money for active trading accounts.